China outsourcing

The All Roads Lead to China Blog did an excellent post the other day, entitled, “Save Money in China GUARANTEED!” Though I wholeheartedly concur with the advice, I must, as a China lawyer add some fine print.

All Roads sets forth a nine fold path for guaranteed cost savings in China outsourcing, of which I highlight the following four:

1) Know what you want to gain by going through this process:

What is the end game?

How much money must be saved before moving?

Should any move involve a gradual shift from current suppliers to new suppliers?

Is a higher cost acceptable until full volume is moved over?

2) Check your gut:

Do you like this person, or do they just have the best price?

Would you hire this person in-house under normal conditions?

Do they respond to your requests for more information?

Do they understand your concerns and work with you to work through them?

Can they do what they say they will?

3) Build relationships and trust:

Many buyers will do all they can to drive down prices and will always be looking for a better deal. this is a strategy that often leads to short term gains and long term pains as relationships are never stable, and both parties are suspicious’. A situation which often leads to supply chain instability and time/ money spent to find new suppliers.

Working with a supplier and developing each other’s businesses is a far more effective strategy that will lead to tighter relationships and long term stability. With China 101 rule #1 being relationships are everything, the above is the goal.

4) Understand and work with relationships when there are problems:

Suppliers will always have a learning curve to climb, and understanding that is critical. No one is perfect, and no process is. There are bound to be issues in quality, and it is not always because a supplier is trying to use lesser quality materials or processes. Sometimes, it is a simple mistake, and at other times it is a serious issue that needs to be talked through. however, if at all possible, one should not simply walk away from the relationship as no one gains from that, especially the buyer.

I urge everyone to check out the full post here. My favorite is “check your gut.” I say this because my firm is surprisingly often brought in to write contracts on deals that simply make no sense for the non-Chinese company. When we ask our client about the portion (or portions) of the deal that make no sense, their response is invariably not to explain it to us from a business perspective, but rather, to tell us that the Chinese company with whom they are doing business has told them “this is what the law requires in China.”

WRONG.

Chinese law is NOT written to harm the foreigner. If the Chinese company with whom you are doing business tells you things that make no sense to you, there is a 99% chance it is nonsensical, rather than that you do not understand China. Just by way of example, the following are some of the things Chinese companies have said to our clients doing that are virtually never true:

You [the foreign company] need to license or give title to your IP to a Chinese company if you are going to be doing business in China.

You need to deposit the initial funds into the personal bank account of the Chinese company’s president.

You need to pay the Chinese government $100,000 to do this kind of business in China, through the Chinese company.

You need to do this business with your having a minority interest in the joint venture.

You need to turn over your client list to the Chinese company so that it can confirm with the Chinese government that none of the companies are forbidden from doing China business.

This sort of business cannot be memorialized in a written contract.

Chinese companies are not allowed to consent to arbitration.

Chinese companies never enter into written contracts

Now for the fine print: Even if you follow all of the above advice, you can still lose money if you have a bad contract, if you pick a bad company with which to do business, if your business in or with China is fundamentally not a good one, or if you fail to protect your IP.

Business everywhere has its risks, and China is, of course, no different.

Liu notes that no Chinese company comes close to rivaling Indian outsourcing powerhouses like Wipro (WIT), Infosys (INFY), or Tata Consultancy Services, and those predicting a quick rise for China’s software industry do not understand the business:

While it’s easy to build up a manufacturing base, creating a knowledge industry takes a lot more time, he says. “Software experience is nothing that you can get very quickly,” Liu points out. “You can rebuild a TV factory that you had in Japan, because most of the work is automated, and workers can be trained very quickly. However, software is a knowledge effort and it takes time for team members to form.”

Liu goes on to predict it will take another ten to twenty years for China to be a big player in the software industry. Is he right? Who will actually lead that charge? Will it be “American” companies like Augmentum, Indian companies like Wipro, Infosys, and Tata (which are already in China and expanding), or will it be local Chinese companies?

Mr. Khalifa starts out by talking about how Gamil’s clients come from all over the world and “it’s a reflection of the times that a small design firm like ours finds itself at the very heart of globalism, fascinating and scary as that is.” He then talks about how, eight years ago, coffee shop owner friends had sought his help in designing a single cup tea infuser, “durable enough to take the abuse that comes from being slung around in a cafe.” Gamil developed what it called “the Teastick, a device that can scoop, infuse, and stir tea. It’s comprised of stainless steel tubing and a perforated sleeve.

Gamil started by having the teastick made in the U.S.A. and this made it proud:

Believing that we had a simple product, we got the prototype made at Design Dimension in Raleigh. We found domestic suppliers for the raw materials fairly easily and believed we were well on our way to showing our clients that it was easy to produce a niche, high-quality item like the Teastick in the United States.

Gamil instantly sold out of a 150 product test run and then immediately sold out of the initial run as well. “We were thrilled that our local product was resonating in New York and L.A.” “Excited about our success, we ordered more,” only to be told that the costs would be double.

The new price was simply too high to warrant continuing production, so Gamil scoured the country for another manufacturer:

We looked all over for a way to revive the Teastick but our problem was scale. We could not find someone who would do a job as small as ours for a price that we could sell in the market. We were now stuck in that same economic predicament that our clients are in. We scoured the country for someone who could produce our Teastick, and continually hounded more than 70 suppliers only to have our drawings faxed back with “No Bid” written across them. The two military contractors who did give us bids listed prices in the stratosphere.

Stubbornly, we decided that our domestic sourcing problem was due to our design being mismatched with domestic capabilities. So we redesigned the Teastick so it could be made from castings (popular in the Midwest). However, the result was too heavy and sloppy to be at home in a fine tea setting. We gave up, and the Teastick was dropped.

A couple years later, Gamil was asked to design some bicycles for a friend’s factory in China. Gamil then realized the equipment used to make the bicycles could also be used to make Teasticks and it soon struck a deal to trade its design work for Teastick production.

Khalifa recites the following lessons learned:

Though I’m a proponent of buying local products for local needs, I have to admit that the current manufacturing atmosphere makes it tough. But I’ve also learned that manufacturing is not just about economics and nationality.

This experience has allowed me to further deepen my relationship with Roger [the manufacturer], and see how we can help each other with projects. Now we’re selling Teasticks at a substantial volume all over the world, including Canada, Australia, Europe, Japan, Taiwan and Korea. In an ironic twist of our place in the global market, our latest and largest opportunity is to sell the Teastick is in China.

Khalifa’s simple, heartfelt, first person account weaves in many of the themes of which we love to write, including the following:

1. Small companies too should consider China outsourcing.

2. Chinese outsourcing can increase U.S. employment, not just reduce it. In this case, without China there would be no teasticks.

3. Due diligence and relationships matter. Gamil went with someone it knew, someone it trusted, and it has stuck with them.

We recently did a post, entitled, “China Outsourcing For Small Businesses — Think Different,” encouraging companies to think about outsourcing projects to China. We intended the post more to provoke thought than as a “how to,” but after two top China bloggers pointed out the risks involved in China outsourcing, we are reverting back to our lawyer training and writing this post to add the requisite lawyerly caveats.

We first receiveda comment from China internet guru (and new father), Sam Flemming, describing outsourcing work his company had overseen in China, but warning of the risks of picking the wrong people for China outsourcing.

Then, in a post appropriately entitled, “Think Different — But Be Careful,” The Black China Hand Blog issued its own warning on China outsourcing by providing one of the many classic examples of what can go wrong when outsourcing to China:

Outsourcing is a fact of life for today’s businesses but for small to medium sized firms outsourcing to China, I think they need to think carefully and know the risks. Indeed, I know of a small Seattle based shop that outsourced its manufacturing to a factory in China. It worked well at first, saving them a certain amount of money. However, they later discovered that their “partner” in China had copied their mold and was manufacturing their own products and selling them in competition with the Seattle firm. These types of stories are a dime-a-dozen for the unwary doing business in China. Big business can hire investigators or lawyers to perform the due-diligence but for the smaller firms accidentally discovering you might be getting ripped off is too high a risk.

The story of the Seattle company having its mold taken by its Chinese OEM manufacturer is indeed such a dime-a-dozen example of what can go wrong with China outsourcing that it took me a second read to ascertain that the Black China Hand was not talking about one of our own clients. But, The Black China Hand is right when he says this sort of thing is a dime-a-dozen.

So am I going to retract my ungrammatical (taken from Apple Computer’s famous ad) exhortation from earlier this week? Absolutely not. In fact, I disagree with the Black China Hand’s saying outsourcing for small and medium sized companies is not worth the risk, because many times it is.

So what is an small or medium sized company (SME) to do in considering whether and how to China outsource?

First, follow the Black China Hand’s advice by recognizing that no matter what you do, there will be risks that must be considered. In other words, conduct the same sort of cost benefit analysis you do in making your various other decisions.

Second, follow Sam Flemming’s advice by using “good people” in China since nothing reduces your risk more than this. If you are just going to pick someone in China quasi-randomly based on price, forget it. The chances of your losing money on that sort of deal are indeed too great. Do an appropriate amount of due diligence.

In our post, I talked about my firm using a Chinese law professor to translate our web site. This law professor is a friend of a China-based lawyer with whom we have worked for years on numerous matters. We trust her and we have our own lawyers fluent in Chinese to oversee. The example of our client who retained someone in China to input accounting numbers is also illustrative. The person who does this was hand-picked by their China office manager, who had every incentive to pick the right person. Work with people you know (at least indirectly) to minimize problems.

Third, be mindful of the stock market expression “pigs get slaughtered,” as it applies to outsourcing as well. When we were looking for someone to translate our site into Chinese, we were looking to save money, but, first and foremost, we were looking for someone good and reliable. We could have used someone to translate our site for half as much as the person we eventually chose, but that person would almost certainly not have done the job nearly so well nor so professionally.

Spend the time and money to find the right person for the project and spend the time and money to make sure you are protected as much as reasonably possible. For example, if you are going to be putting your IP or trade secrets at risk, pay an experienced attorney to draft the proper contract, in both English and Chinese. If your Chinese company is going to be using your molds, get a contract that makes clear the molds belong to you and, as a further protection, look into registering your IP in China.

I realize the title is a bit ungrammatical, but like Apple Computer, I am using it for emphasis. The Virtual China Blog had great post the other day, entitled, “China’s virtual goods business booming,” on companies in Harbin, China, that create and sell computer gaming virtual characters. The post consists in large part of a translation of an article from the Harbin Daily on the “proxy player” business:

After two years of hard work, business at Chen Xiao’s “proxy player” business — selling virtual currency, equipment, and game characters — is on the rise. Chen is one of Harbin’s first group of virtual goods merchants. As the article explains, proxy player shops arose to serve those who love online games but don’t have the skills or the time to develop a mature character. Instead, they simply buy what they need. The people who are hired to develop virtual assets in-game are called “online game proxy players”.

I see this as another way in which small businesses are taking advantage of global wage differentials.

I was recently interviewed by Law.com for an upcoming story on boutique international law firms. The magazine asked me about the cost of getting my firm’s website into five different languages, including Chinese. I told her we had kept costs down by outsourcing overseas. We had a Chinese law professor out of Dalian do the translation and though we paid her very well by Chinese standards, I would estimate we saved around $5,000, as compared to using a U.S. based translator.

The reporter seemed fascinated by this and we got off track discussing other examples of small firm outsourcing to China. I told her about a client of ours with around ten employees that uses someone in China to input into digital form all of the numbers from each day’s transactions. At the end of each day, the client scans in its bills of ladings, invoices, receipts, etc., then e-mails them to China and has them in digital format by the next morning. I am guessing this client is saving around $1,500 per month with this arrangement. We have a small business client who had a Chinese company design its website, saving itself thousands of dollars.

Just came across a week-old blog that shows much potential. Called “Go East – Outsourcing to China’ [it no longer exists] the thrust of this blog will be China outsourcing, mostly of the IT kind. One of the great things I have found about reading other people’s China blogs is the knowledge of internet resources the bloggers have within their own field. Go East links to a number of excellent articles on China technology outsourcing, which the China lawyers at my firm are convinced will be a growth industry.

The other day I was thinking that one of the most surprising things I have learned since starting this blog is how insightful the industry press can be on China. Some of my favorite articles on which to blog have come from industry sites like CSO Online and Automotive News, which look at China from a micro perspective, and thus are less likely to be tainted by politics. I will no doubt be pulling IT outsourcing articles from Go East.

Business Week’s cover story is on outsourcing and the magazine contains a number of very interesting and informative articles on the topic, including much on China outsourcing. BW does an excellent job handling this controversial subject in a factual and unbiased manner. If you are outsourcing products or services to China or even contemplating that, you absolutely should check it out.

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We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.